Endowments cold comfort in short term

Cost of early surrender and high charges mean a poor return for many, writes Clifford German

MILLIONS of people have been pressured to take out endowment mortgages that may not suit their circumstances. The fact is not new and has been widely publicised. But an Office of Fair Trading report last Friday quantified for the first time the amounts home buyers might lose in typical cases where endowment policies are surrendered early or where charges are high.

Unlike the mis-selling of personal pensions, which without the proposed compensation would have cost individual victims tens of thousands in lost pension entitlements, the extra costs of an endowment mortgage will be measured in single thousands of pounds. And most borrowers who took out endowment mortgages in the 1970s and early 1980s and hold them to maturity will still have made the right decision. Their policies will pay out enough to cover extra costs, redeem the mortgage in full and provide a windfall profit.

But the point the OFT report makes is that anyone who fails to keep a policy until it matures is likely to lose money because of the low surrender values that insurance companies traditionally offer. Amazingly, there are still no firm figures for how many endowment policies are surrendered early. But if the experience of other insurance policies is any guide, maybe three- quarters of all policies will lapse before they mature.

The best advice for everyone with an existing endowment mortgage is to hold on to it when moving home rather than surrendering to take out a new policy. Anyone trading up and borrowing more should top up the policy rather than take out a new replacement. Those who cease to be owner-occupiers and move to the rented sector should consider selling their policies or continuing them as a pure investment rather than surrendering them.

The climate has however been turning against endowment mortgages and back in favour of repayment mortgages for several years now. For one thing, in the new climate of low inflation it is harder for insurance companies to make the big profits from investing the premiums that made endowment policies look the better bet in the days of high inflation.

For another, real interest rates are higher and more of a burden than they used to be on endowment mortgages, where the debt remains undiminished to the end of the mortgage period because the non-interest contribution is used to buy the policy rather than pay off the loan.

The Government has also given the endowment policy a series of knocks by pegging the maximum amount of mortgage eligible for tax relief, abolishing relief at the top rate of 40 per cent, then at the standard rate of 25 per cent, and then reducing the relief in the current year to just 15 per cent of the interest payment.

But this cannot disguise the fact that even now 60 per cent of all home buyers are still being persuaded to take out a mortgage linked to an endowment policy, whereas the number for whom they will be the best buy could be as low as 20 per cent. This is after allowing not just for early surrenders but also the large number of home-owners who have no other assets as a cushion against redundancy, sickness or other financial emergencies and cannot maintain the premiums, which unlike the capital payments on a repayment mortgage cannot be deferred. It also includes those who pay endowment premiums out of overdrafts and end up paying interest on the premiums.

The fact is that too many people have been persuaded to take out endowment policies in the past decade through a combination of ignorance and the greed of mortgage salesmen, agents and advisers - who recommended endowments because they earned commission on any they sold while repayment mortgages paid them nothing.

The Consumers' Association thinks the Financial Services Act should be extended to cover all aspects of mortgage advice, although Sir Bryan Carsberg, Director-General of Fair Trading, believes extending the legislation would take too long to implement, and it will be enough if lenders, agents and advisers go out of their way to offer borrowers an informed choice of mortgage. Borrowers also need to look at performance indicators before accepting an endowment mortgage.

According to a General Accident spokesman, the crucial indicators are not the standard target yields that insurance companies are allowed to project, but the reduction in yield due to charges and expenses, the surrender values individual companies offer for early redemption of endowment policies and the free asset ratios of the insurance companies. The better the ratios, the more freedom the company has to invest for maximum long-term growth.